Breaking Taboos – How Importing a Franchise can Great for Business

The concept of globalisation in business has become a reality. Walk into any major shopping centre in Dubai, and one would be forgiven for thinking they were in Melbourne, Auckland or the United Kingdom. There are variations to some of the brands but there are an increasing number of brands that are instantly recognisable to the average consumer. How does this happen?

At a grass roots level there are an increasing number of businesses focused on international expansion. Depending on the perspective, this is importing or exporting. Adrian McFedries, Managing Director DC Strategy discusses some of the issues related to importing franchise systems from overseas as part one of a two part series. Part two will focus on franchising as part of an international expansion strategy.

The importing of international franchise systems has for a long time been an area of business that is misunderstood and approached with trepidation on the part of some prospective investors. Anecdotally a very small number (10-20%) of franchise businesses entering Australia succeed over the medium term. Given this fact the trepidation may appear well grounded but closer inspection provides some insight. There are a number of well recognised success stories that demonstrate global businesses can be successful in multiple markets. In Australia Body Shop, Gloria Jeans, Kmart, Hungry Jacks, Bang & Olufsen, Signarama, Mrs Fields, Domino’s Pizza, and Subway are well established businesses operating under some form of franchise or license structure.

Choice of Structure

There are a number of types of franchise structure being utilised in international expansion. The more commonly recognised include, but are not limited to, master franchise or license, area developer, or direct unit franchise. In each structure there is a key decision in terms of the sharing of responsibilities and level of involvement of the parent company and the prospective franchisee. There is a degree of confusion in relation to the structures and how they differentiate from each other. It is beyond the scope of this article to provide an exhaustive definition but it is worth noting in the larger countries such as the United Kingdom, France, and the United States of America (US), master franchising is more an international structure. The terms area developer and master franchise are used more interchangeably in Australia.

The choice of format is usually determined by the parent company overseas but there may be a certain level of negotiation at the local country level with the prospective franchisee. The structure used is one of the most important decisions for the business as it can significantly impede or advantage the development of the business by the prospective franchisee in Australia.

The most common structure for an international franchise is the master franchise or license. The master franchise structure will grant the rights to a certain territory or region for a period of time specified in the legal agreement. The master franchise structure would more commonly be national, with the Australian master franchisor having the rights to grant and operate franchises and company operations with the country. The individual ‘sub’ franchises within Australia would typically be granted direct with the Australian master franchise. The other option is a master franchise model on a state by state basis or some break up of territories within Australia to individual franchise operators. The legal agreement will prescribe the details for the operation of the business such as financial arrangements, territory, use of intellectual property etc. Whether the structure is deemed a license or franchise rests on the interpretation of the business system within the context of the Franchise Code of Conduct prescribed under section 51AE of the Trade Practices Act 1974. It is common for international groups to term the arrangement license while the Australian interpretation is franchise.

A local example of a master franchise/ license is the Body Shop operation.

The area developer structure is an arrangement where the Australian franchisee is granted the rights to develop a determined area and any ‘sub’ franchises are usually granted direct with the parent company. The area developer structure more commonly results in a country being broken into multiple territories rather than a single area developer for an entire country. The perceived advantage to the parent company is having a more decentralised business model with more concentrated focus by multiple parties.

A local example of an area developer structure is the Subway operation.

The direct unit franchise is probably the least common of the international franchise structures, at least in Australia. The direct unit franchise structure has each individual franchise granted direct between individual site or store and the parent company. The real challenge with this model is the ability to provide the necessary leadership and direction to the group when the parent company is so removed geographically. The geographic isolation of Australia explains this phenomenon. In Europe it is more common to experience a direct unit franchise structure as the modus operandi for international growth between neighbouring countries.

The company-operated structure is self explanatory and provides limited, if any, opportunity for an Australian franchisee. The exception to this would be if a joint venture arrangement were formed between an Australian investor and the parent company. The joint venture could operate a mixture of company operated or franchised operations in a structure of master, area developer or direct unit franchise. The latter is most likely as the joint venture involvement of the parent company demonstrates a level of investment or interest in the country that would predispose them to the direct unit franchise.

It is possible the structure could be a combination of the above and it will evolve over the years as businesses react to market forces or changes in demand or performance.

A local example of a company owned structure is the Starbucks operation.

The Process

The process for acquiring an international franchise opportunity for Australia is extremely varied. The reason for this is the variety introduced by the people involved in the process – the parent company and the prospective Australian investor.

In simple terms there are two primary means by which the international franchise opportunities are being identified; proactive and reactive. The proactive approach is where an interested investor or group searches the globe for opportunities that may be implemented in Australia. This can be a direct visit, or countless hours of Internet searching, or both. Given the globalisation of modern technology and travel there is more of this activity in the past 10 years than in earlier times. This does not always lead to a master franchise or franchise being imported. An investor can use the trip as a fact finding mission to identify a business to establish in Australia from scratch. A good example is John O’Brien from PoolWerx who researched the world markets before establishing the Australian based and owned PoolWerx operation.

The reactive approach is a response to some form of advertisement or direct approach to the Australian market. There are regular advertisements in the Financial Review, Franchise Magazine and various other publications seeking an investor to operate an international franchise business. There are an increasing number of international events or seminars being hosted in Australia where the parent company arrives in Australia for the direct purpose of securing the commitment of a local investor.

Irrespective of the approach employed to identify the investment opportunity the first few months will be where the detail and final decision will be made. The average tenure to identify, negotiate, and sign the agreement phase is 2-3 months. Naturally there are exceptions. The negotiation phase is the most critical in the experience of DCS.

This phase must remove the emotional attraction of the business, and focus on the cold hard facts. The emotional attraction is not easy to diminish as people are often travelling to foreign destinations which creates a level of novelty or variety. The evaluation of the facts and substance of the business opportunity are no different to conducting a due diligence. There are operational, financial, marketing, legal, and people components to consider, amongst others, that combine to provide the basis of a decision. Critically, the business will not usually be in existence in Australia at the time of evaluation and this is probably the most difficult issue. It is one thing to consider the success of a business in a foreign country but a closer evaluation of local market issues needs to be understood. For example, it is not uncommon for US based systems to produce financial data that has artificially low wages due to the prominence of tipping in the US. This can have a major impact on the importation of the business into the Australian market.

During the evaluation phase there are a series of opportunities to gain insight into the thinking and actions of the parent company. Some will be very minor, but will be critical. In the experience of DC Strategy, the level of preparation by the parent company for the international expansion is high on the agenda. A recent example where a New Zealand based company purchased the rights to Australia and New Zealand from a US parent company, demonstrated the trademark and domain name had not been secured for either country. Not surprisingly, this was a case of proactive action by the prospective investor in New Zealand approaching the US parent.

There are numerous areas to focus on which are beyond the scope of this article but every prospective investor should look closely at the level of leadership and what is actually be offered as part of the negotiation. Is there a well defined process of operation, access to overseas intellectual property, information technology, and training?

As with due diligence, the risk of investment is never removed but the decision can be made on a much more informed basis. Anyone who is not comfortable with their experience with the overseas parent should ask themselves whether this is the start of a long and successful business relationship or a reason to walk away.

The Advantages and Disadvantages

There are many advantages and disadvantages associated with importing an international business into Australia. To propose an exhaustive list would be futile as many are a direct function of issues specific to the business. There are some broad areas worth considering.

Advantages

? The ability to leverage the proven systems and intellectual property of an existing business rather than develop everything from inception

? The opportunity for leadership and direction from the parent company in an initial and ongoing format

? The knowledge transfer associated with being part of a larger network

? The liquidity value of a business with an internationally recognised brand with operations in multiple countries

? The ability to achieve a more consistent return on investment in the early stages

? The reduction in development expenditure as distinct to growth or implementation expenditure

? The ability to benefit from the mistakes made in the international business

Disadvantages

? The uncertainty of how relevant the international intellectual property, support and systems are to the country that will import the system

? The impact of the financial remuneration being paid to an overseas parent in the start up phase of the business in Australia if the systems that are being paid for are inadequate and need to be redeveloped

? The potential that the parent company has a change of heart or direction in the future that has a detrimental impact on the Australian business

? The supply side relationship is dependent on the parent continuing to understand the evolving needs of the local market

Any of these issues needs to be considered by the prospective investor as part of the decision making process. There are instances where issues can be resolved without undermining the opportunity. In the early days of the Mrs Fields food retail business in Australia supply side issues arose due to the fact the US sold the biscuits based on weight. This approach meant in Australia the ability to sell individual biscuits or pre-packaged packs to a specified weight was difficult. This issue was not resolved until manufacturing was localised in Australia.

The most difficult decision many prospective franchisees have to address is whether the initial fee and prospect of ongoing payments is worth the value. After understanding the business some people decide the perceived value is not sufficient enough and as a result a self built business is a better option. This is a personal decision but it is worth noting the start up phase of a business is treacherous and the amount of time establishing processes and systems is significant in the early years. It could be suggested these are not necessary but in reality processes and systems are critical if an expanded and sizeable business is the objective. Duncan Eley, a Senior Consultant at DC Strategy notes “most operators of businesses underestimate the amount of time taken to develop the necessary processes in a business, often to their detriment.”

The advantages of being part of a large international network can be extremely beneficial with access to intellectual property, supply chain, and knowledge transfer being among the most significant. The other countries of operation offer innovations and demonstrate how challenges can be addressed. McDonalds is an excellent example of local initiatives such as the Big Mac or Ronald McDonald being implemented all around the world. Groups such as Body Shop, which is operated in Australian by the Adidem Group under a license arrangement, have exceptional supply chain opportunities as part of the international Body Shop network.

David Buys Goliath

An interesting trend that is starting to emerge in Australia is the prospect of the Australian master franchise buying out the overseas parent company. How could this happen and why? There is no better recent example than the Gloria Jeans operation in Australia. Gloria Jeans Australia was originally a master franchise arrangement from the US parent company but after a handful of years on the back of successful Australian growth the master acquired the US parent company. This has a logical conclusion that the Australian business was better operated than the parent company and consequently created the opportunity. This is not necessarily the case, but certainly as time passes the real opportunity that presents itself is the Australian parent company becoming the driver the of the international expansion strategy.

This is a trend that will continue between countries all around the world. One of the drivers is the increasing access to private equity or capital which is the necessary fuel to conclude deals. Australian networks have a strong reputation globally for operating businesses across massive geographic regions with high fixed costs, labour costs, and a small population. Consider operating a retail network of 100 stores with one third of the population of Germany across an area that encompasses all of Europe. That is Australian retail.

Domino’s Pizza is another strong example of a local Australian business operating under a master franchise arrangement that has gone from strength to strength. After strong growth across Australia, and an IPO, the Australian master franchise has acquired the master rights to Belgium, France and the Netherlands, as part of the continuing growth trajectory for the listed entity.

This trend does not suggest the initial investment to acquire the master, area developer or license is undermined by any future offshore growth. It is the opposite. Being part of an international network can create a further opportunity for overseas growth as it has for Gloria Jeans. The prospect of building a self built business is attractive but a different proposition to the value created by importing an international business into Australia.

The continuation of international globalisation is a certainty. As a consequence there will continue to be business concepts or operations that are imported into the Australian market. For those considering this as a growth trajectory you would be well advised to make sure you make a fact based, fully informed decision. Ensure the appropriate magnitude of capital investment is identified for the initial investment and the early growth of the business. If the opportunity has issues that do not sit well with you, get advice to understand if they are an anomaly or if they are a reason to walk. There is no point forming an emotional attachment to a business or being sold on the fact “someone in Australia will buy the rights if you don’t”. There will always be another opportunity and who knows, you could be the next Subway, Gloria Jeans or Hungry Jacks.